Bigger is better for banks this earnings season.
A deposit run that felled Silicon Valley Bank and Signature Bank has hurt small banks much more than big ones, draining low-cost funding that has fueled their profitability in recent years.
Even before last month's turmoil rocked the industry, banks were passing on more of the benefits of higher interest rates to their customers. Now, an expected pullback in lending is likely to further dent profitability, while paper losses on banks' bond portfolios could limit their ability to return capital to shareholders.
The suffering probably won't be distributed evenly across the industry.
Analysts at Morgan Stanley cut their per-share earnings estimates for 13 of the largest U.S. banks by a median of 4% for 2023 and 15% for 2024. For midsize banks, the outlook is far worse: Morgan Stanley analysts cut their average 2023 and 2024 per-share earnings estimates by 17% and 27%, respectively.
This earnings season is the most challenging one for midsize banks since the 2008 financial crisis, where "so much is heading in the wrong direction" and a "jungle of potential pitfalls" awaits, Evercore ISI analysts said in a research note last week.
Citigroup Inc., JPMorgan Chase & Co., PNC Financial Services Group Inc. and Wells Fargo & Co. are scheduled to report their first-quarter results before the market opens Friday. Other banks will follow suit next week.
Bank deposits peaked in April 2022, shortly after the Federal Reserve started increasing its benchmark rate to fight inflation. A trickle of outflows over the ensuing months grew into a flood in March, after concerns about SVB and Signature's business models caused a broader banking run that overwhelmed both lenders.
About $312 billion in deposits left the banking system between March 1 and March 29, according to Federal Reserve data. The 25 biggest U.S. banks gained $18 billion over the course of the month. All the U.S. banks below that level lost about $212 billion during the same period.
Deposits are banks' lifeblood, and the threat of more of them disappearing has led many to banks to hike the yields they offer to account holders. Meanwhile, uncertainty about funding means that bank loan officers will likely need to pull back on new offers of credit.
Both maneuvers eat into the profits that banks earn on lending. After SVB and Signature failed, Morgan Stanley analysts reduced their estimates for net interest income at the median large bank they cover by 0.5% for 2023. At midsize banks, Morgan Stanley analysts reduced net interest income estimates by 7.1% on average.
Consumers and companies are already bracing for tougher times accessing credit. A greater share of households told researchers from the Federal Reserve Bank of New York that it was harder to get a loan in March than in any other month since its survey of consumer expectations started in 2013.
First-quarter profits could also take a hit if more banks were forced to sell portions of their bond portfolios at losses to honor withdrawal requests from depositors.
Banks loaded up on bond purchases during the pandemic when government stimulus and pandemic aid programs were bringing trillions of dollars of new deposits to their balance sheets. Typically, those portfolios are filled with fixed-rate debt that is at low risk of default. But when interest rates started rising last year, prices of existing bonds fell, leaving banks with paper losses.
Unrealized losses on bank investment securities totaled $620 billion at the end of the fourth quarter, according to the Federal Deposit Insurance Corp. Those lower marks don't affect banks' earnings unless they actually need to sell the bonds, a drastic move that most would prefer not to take because it could signal distress.
Silvergate Capital Corp. recognized $718 million in losses on debt investments that it sold earlier this year. Two months later, the crypto-focused bank announced it was winding down. Depositors fled after SVB recognized about $1.8 billion in losses after taxes on sales of bonds from its investment portfolios. It failed the same week.
Accounting and regulatory rules dictate that certain paper losses on bond investments eat into some banks' capital levels. That, plus concerns about higher future capital requirements and the economic environment, are likely to lower payouts to bank shareholders, according to analysts.
Some banks are already taking that step. Embattled lender $First Republic Bank(FRC-N)$ suspended its dividend to common shareholders in mid-March after it suffered a deposit run triggered by SVB's collapse. Last week, it announced that it would also halt dividends on its preferred stock.
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